Sunday, May 29, 2016

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on research outlined in our post Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model to look for changes in direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bullish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.

The latest signals of each model are as follows:

Ultimate market timing model: Buy equities*

Trend Model signal: Neutral*

Trading model: Bearish*

* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.

Not turning bearish yet
No, my inner investor isn't turning bearish, but I believe it is prudent to be thinking about how a market top develops. The bull market that began in 2009 is getting mature and I am getting starting to watch for signs that a market top is developing. My analytical framework is as follows:

Macro-economic analysis: I am grateful for the work by New Deal democrat in his recent post A roadmap to the next recession. This chart from Gene Epstein at Barron's shows the risks to equities should economic growth stall and roll over. While stock prices can fall and correct at any time, the most severe declines have been associated with recessions.

Growth and valuation: I think of stocks in terms of the two components of the PE ratio. First, how much is E like to grow? Second, will the P/E ratio expand or contract? The big question in the current environment is the intersection of growing E as the Fed embarks on a tightening cycle. How will stock prices respond as earnings rise, but higher interest rates puts downward pressure on the P/E ratio?

Thursday, May 26, 2016

As the oil price touched $50, there has been a growing paradigm shift, a sort of "this time is different", consensus forming about the long-term outlook for oil prices. Amy Myers Jaffe of UC Davis recently addressed the 69th CFA Institute Conference and made the following bearish points about the long run trajectory of oil prices:

Demand: Global demand growth is set to slow, flatten and perhaps fall as countries start to adopt alternative energy sources. Indeed, Bloomberg recently reported that there are more people employed in renewable energy in China than oil and gas. Similarly, solar power related employment has surpassed employment related to coal and oil and gas combined in the United States.\

Supply: The fracking revolution is a revolution. For the first time in history, advances in engineering has allowed us to extract oil and gas from oil bearing rock, which means that any geology that formerly produced oil, such as Pennsylvania, is has the potential to produce oil again. Jaffe did not, however, address the cost question and said in so many words that these are engineering problems, which can be solved over time.

In effect, don`t expect much more upside in the price of oil.

Independent of Jaffe's analysis, Bloomberg Gadfly column by Liam Denning used similar assumptions about oil prices and suggested a strategy by the Big Oil companies is in order:

Like OPEC, they [Big Oil] assumed the value of their reserves of this finite, critical commodity would, more or less, keep rising over time. So a barrel not produced today, even if it cost a lot to find or acquire, is effectively money in the bank. This is why the majors obsess over their reserves replacement ratio, measuring how many new barrels come in to replace the ones they pump out.

Now, the upcoming Saudi Aramco IPO raises one troubling possibility: That the assumption of endlessly rising reserve value may no longer hold true.

A flurry of paradigm-shifting announcements out of Saudi Arabia came soon after a speech in October by BP's chief economist. He posited that the shale boom undercut the notion of peak oil supply, while efforts to curb carbon emissions raised the possibility of peak demand.

Denning went on to suggest that the upcoming partial privatization of up to 5% of Saudi Aramco representing a Saudi strategic shift to produce at any price, rather than to bank the oil in the ground because it is becoming a commodity with diminishing value.

Saudi Arabia's sudden desire to sell shares in its national champion and generally shift the entire economy away from its oil addiction suggests it at least entertains those possibilities. It also provides a rationale to maximize production at any price, rather than risk barrels being left worthless in the ground.

Shale boom + carbon emissions curb = Peak Oil demand. It's time to change the thinking on the management of this resource and sell it as fast as possible because some of those assets will become stranded in the future. Call it the Hot Potato Theory of oil.

Since then, the SPX weakened to test an important technical support at 2040, which represents the neckline of a potential head and shoulders formation. (As all good technicians know, a head and shoulders formation isn't complete until the neckline is broken.) While the market did break 2040 last week on an intra-day basis, neckline support held. In addition, the NASDAQ Composite confirmed the strength today by staging an upside breakout through resistance.

At the time of the bearish trading call, I said that I would turn bullish if:

The US stock market got oversold and sentiment models flashed a crowded short reading; o

Monday, May 23, 2016

Further to my last post (see Three steps and a stumble?), I would like to clear up some misconceptions about how I interpret the yield curve and its investment implications. Much of the confusion revolves around the idea of correlation vs. causation. Yield curve inversions don't cause anything. Yield curve inversions are a signal (correlation) of certain effects that have important investment implications.

Sunday, May 22, 2016

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on research outlined in our post Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model to look for changes in direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bullish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.

The latest signals of each model are as follows:

Ultimate market timing model: Buy equities*

Trend Model signal: Neutral*

Trading model: Bearish*

* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.

Some good news and bad news
The market action last week played out roughly as I expected. Stock prices were choppy and displayed a series of lower highs and lower lows, though the technically important 2040 support neckline of the head and shoulders pattern did not break decisively (see Waiting for the storm to pass). The short-term trend remains down and key intermediate term indicators has not reach oversold levels, as measured by the NYSE McClellan Oscillator (NYMO) breaching the -80 level and VIX Index moving above its Bollinger Band, which suggests that the current corrective action isn't finished.

There was some good news and bad news as stocks declined...

...specifically, I would like to explore the possibility of the bearish three steps and a stumble scenario, which follows the old trading adage of three Fed tightening moves will tend to lead to a stock market stumble. This scenario is becoming a real possibility as the US economy is still in a fragile state.

Thursday, May 19, 2016

How would you feel if the average doctor was right 55% of the time? What if a "superstar" doctor, the one whose new patient waiting list stretched out for 1-2 years, was right 60-70% of the time?

That's how thing work in investing. A "good" quantitative factor, or system, is often acceptable if it has a 55% success rate. If you get a 65% success rate, you are a superstar. Some systems have success rates of less than 50%, but the average value of their wins dwarf the average value of their losses.

Finance quants are often said to suffer science envy. They employ scientific techniques to find alpha, but they do it in an environment where the signal-to-noise ratio is very low. Let`s not kid ourselves, we know what day traders, swing traders and system traders really do.

By contrast, the signal-to-noise in the sciences tend to be higher. Viewed in isolation, that can be a cautionary tale for all quant researchers and systems traders who think that they may have found their path to riches.

Wednesday, May 18, 2016

Mid-week market update: No, it isn't just a more hawkish Federal Reserve that's spooking the stock market. Stock prices were been falling before Fedspeak and the latest FOMC minutes sounded a more hawkish tone. The SPX staged a successful test of its 2040 neckline support of its head and shoulders pattern today. In fact, today`s action could be interpreted constructively as it is experiencing a minor positive divergence on RSI-5.

Don`t blame the Fed. Market weakness is a symptom, not the cause of the retreat.

The latest BoAML Fund Manager Survey revealed the top two tail-risks on fund managers' minds were Brexit and China, which did not appear as a source of concern in the previous month's survey. It's no wonder that the markets are getting spooked.

Here's how I am preparing myself and how I would watch for the turn upwards, should it come.

Monday, May 16, 2016

China has been undergoing a series of stop-start growth spurts mini-cycles, courtesy of credit driven stimulus programs (chart via RBS):

The size of the latest Q1 financing induced boom was extraordinary, as it hinted at panic by the authorities. For some perspective, credit expansion in Q1 2016 was somewhere between the GDP of Indonesia and Mexico:

The April readings marked a sharp swing in fortunes, especially in new credit: where March saw aggregate financing jump by more than all economists had forecast, April’s number undershot all 26 predictions. Such gyrations -- long a feature of the nation’s stock market -- add to the challenge for policy makers and foreign investors seeking to get a read on an economy caught in a multi-year slowdown and struggling to stabilize.

Total social financing plummeted to levels not seen since 2013 (Deutsche Bank via Business Insider):

Things got so bad that the PBoC felt compelled to reassure the markets that it would continue to support the economy through monetary policy (via Bloomberg):

China’s central bank reassured investors that monetary policy will continue to support the economy after a sharp slowdown in new credit last month, and said the lending slump was temporary.

The deceleration in the growth of new yuan loans in April was mainly due to a pick-up in a program to swap high-cost local government debt for cheaper municipal bonds, the People’s Bank of China said in a statement on its website on Saturday. No less than 350 billion yuan ($53.6 billion) of such swaps were conducted last month, while aggregating financing growth was affected partly by a decrease in corporate bond issuance, according to the central bank.

Sunday, May 15, 2016

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on research outlined in our post Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model to look for changes in direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bullish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.

The latest signals of each model are as follows:

Ultimate market timing model: Buy equities*

Trend Model signal: Risk-on*

Trading model: Bullish*

* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.

Don't panic, it's only a correction
My last blog post created a bit of a stir among readers as I was inundated with questions (see Tactically taking profits in the commodity and reflation trade). To reiterate, I made a trading call to get more cautious based on a developing slowdown coming from China, which was signaled by falling commodity and Asian stock prices.

At worst, this growth scare will result in nothing more than a minor US equity correction. The intermediate term outlook remains bullish. How would you feel about equity prices if I told you:

Earnings are continuing to recover

Fed policy is dovish and equity friendly

Put simply, stock prices depend on two factors. The first is earnings, or the E in the P/E ratio - and earnings are growing. The second is the P/E multiple, which is a function of the outlook for interest rates and future growth, both of which are showing equity friendly tendencies.

The growth scare recedes and the market pushes upwards to test and possibly exceed the all-time highs;

The growth scare continues, which results in a choppy range-bound market; or

The growth scare intensifies and the market breaks support, with a measured SPX target of 1970-1980.

It seems that circumstances are converging towards scenario 2 and 3. It`s time to make a call to take trading profits in both the long SPX and commodity positions. The combination of excessive market positioning and weakness in China are raising red flags, from the viewpoints of cross-asset and inter-market analysis.

Monday, May 9, 2016

Let me make myself very clear. As a Canadian, I have no horse in the American presidential race, but Donald Trump is a clown. He is a loose cannon on deck. He could also become the next president of the United States.

So when does the market start to discount the potential effects of a Trump presidency?

We would like to announce our "Sale in May" event, where you can get US$50 off the first year of an annual subscription. This offer is only available to the first 100 who sign up or until May 31, whichever comes first. Anything like this we do usually sells out fast so I suggest that you sign up ASAP before missing this golden opportunity.

Sunday, May 8, 2016

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on research outlined in our post Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model seeks to answer the question, "Is the trend getting better (bullish) or worse (bearish)?" The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of this model has shown turnover rates of about 200% per month.

The latest signals of each model are as follows:

Ultimate market timing model: Buy equities*

Trend Model signal: Risk-on*

Trading model: Bullish*

* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.

Price vs. fundamental momentum
The stock market got another growth scare last week when it weakened last Tuesday, after a dismal set of PMI reports, and ended with a Non-Farm Payroll miss in the US Employment report. I was reminded of an article by Kurt Feuerman and James Tierney Jr. of AllianceBernstein entitled Don`t Confuse Price with Business Momentum:

Momentum is a funny thing. Share price momentum isn`t necessarily an indicator of business momentum. Sometimes a stock is falling simply because investors are taking profits after its outperformance or because a portfolio is changing its risk profile in a volatile market. There are countless reasons why share prices move.

Last year's narrow market is a case in point. Investors might assume that the underperformance of a large swath of the U.S. stock market means that most companies are in bad shape. There is, however, another plausible interpretation: It could also mean that there are a lot of buying opportunities in undervalued companies, ones that have a much better business than is widely believed.

In other words, don`t confuse price momentum with fundamental momentum. So what's the trend in macro and fundamental momentum?

We would like to announce our "Sale in May" event, where you can get US$50 off the first year of an annual subscription. This offer is only available to the first 100 who sign up or until May 31, whichever comes first. Anything like this we do usually sells out fast so I suggest that you sign up ASAP before missing this golden opportunity.

Wednesday, May 4, 2016

Mid-week market update: In the short run, the SPX has pulled back and appear to be about to test its 50 day moving average (dma) at 2040, while experiencing a positive divergence on RSI-5.

The SPX saw a Golden Cross last week - and the right way to trade these signals is to use the faster moving average as a trailing stop. Until the 50 dma is breached in a definitive way, my inclination is to give the bull case the benefit of the doubt.

We would like to announce our "Sale in May" event, where you can get US$50 off the first year of an annual subscription. This offer is only available to the first 100 who sign up or until May 31, whichever comes first. Anything like this we do usually sells out fast so I suggest that you sign up ASAP before missing this golden opportunity.

Monday, May 2, 2016

Unemployment is now at 5.0%, which is a point at which the economy historically started to experience cost-push inflation.

Inflation edges up, which is already being seen in commodity prices.

Initially, the Fed is content to let inflation run a little "hot" because of what it perceives to be slack in the labor market, but as inflation and inflationary expectations tick up...

The Fed finds that it is behind the curve and responds with a series of rapid rate hikes.

The economy slows and goes into recession.

Stock prices fall as the probability of a recession spikes and a bear market begins.

The biggest variable is timing. I believe that we are roughly at phase 2 of this process. Despite the possibility of a market top on the horizon, it is too early for investors to get overly defensive right now. There is still money to be made as growth expectations ramp up (see How the SP 500 could get to 2400 this year).

Then I came upon a note from a reader, who used a rule-of-thumb of an 80% run-up in oil prices as a precursor signal to a recession and bear market. 80%??? Crude oil bottomed in February at about $27 and we are nearly there! (He later amended that comment to an 80% year-over-year change in oil prices.)

Website notice
We would like to announce our "Sale in May" event, where you can get US$50 off the first year of an annual subscription. This offer is only available to the first 100 who sign up or until May 31, whichever comes first. Anything like this we do usually sells out fast so I suggest that you sign up ASAP before missing this golden opportunity.

Sunday, May 1, 2016

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on research outlined in our post Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model seeks to answer the question, "Is the trend getting better (bullish) or worse (bearish)?" The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of this model has shown turnover rates of about 200% per month.

The latest signals of each model are as follows:

Ultimate market timing model: Buy equities*

Trend Model signal: Risk-on*

Trading model: Bullish*

* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet any changes during the week at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.

Strong momentum = Bullish
Call it what you want: momentum, broad based breadth, price trend. Despite the short-term consolidation shown by the stock market, the signs of positive momentum make it difficult to be intermediate term bearish.

I can see it in the trading signals of my Trend Model, which turned bullish soon after the February bottom. The prolonged length of the signal is indications of momentum, trend and powerful breadth thrust.

Website notice
We would like to announce our "Sale in May" event, where you can get US$50 off the first year of an annual subscription. This offer is only available to the first 100 who sign up or until May 31, whichever comes first. Anything like this we do usually sells out fast so I suggest that you sign up ASAP before missing this golden opportunity.

We've moved!

Welcome to my blog Humble Student of the Markets. These are my observations and musings about the markets (mostly equities), hedge funds and investments in general.My experience has been a quantitative equity manager in US, Canada, EAFE and Emerging Markets and commentator on hedge funds and their returns patterns.

DISCLAIMERThis is not investment advice! I know nothing about you, your risk preferences, your portfolio or your investment horizon. I have no idea whether any of my opinions expressed are suitable for you.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. I may hold or control long or short positions in the securities or instruments mentioned.